A qualified charitable distribution, also known as a QCD, can help reduce the taxes you pay on your annual required minimum distributions (RMDs). This strategy allows you to give to charity while limiting your tax burden after you turn 70.

When reaching age 72 (or 70.5 if you were born before July 1, 1949), you need to start withdrawing money from your retirement accounts. These withdrawals must meet or exceed your RMD amount to avoid paying penalties. The withdrawals are taxed as ordinary income and can potentially wreak havoc on your taxes. This is where qualified charitable distributions come into play.

What Is a Qualified Charitable Distribution?

A qualified charitable distribution is a nontaxable distribution made from an individual retirement account (IRA) to a qualified charity. QCDs can only be made from an IRA (traditional, rollover, inherited, SIMPLE, and SEP), not a 401(k) or 403(b). Conducting a QCD from a SEP or SIMPLE IRA can only take place as long as the account is not receiving active contributions.

You need to meet specific requirements to enjoy the tax advantages of a QCD, which include:

Lowering your taxable income
Reducing your required minimum distribution
Available with a standard deduction

The amount distributed to the qualified charity not only lowers your taxable income but counts toward satisfying your calendar-year RMD.

As an example:

Barbara’s 2021 RMD is $18,500. She decides to donate $10,000 from her IRA to various charities via a QCD. This means Barbara needs to withdraw only $8,500 ($18,500 - $10,000) to satisfy her 2021 RMD and must pay income tax on only this amount.

Qualified charitable distributions are also available when using a standardized deduction. You do not need to use itemized deductions to claim the QCD.

IRS Rules for Claiming a Qualified Charitable Distribution

You must be at least 70.5 years old (yes, this is an age based on the old 70.5 start age for RMDs and was left unchanged) to be eligible for a qualified charitable distribution. The distribution cannot exceed your adjusted gross income, and the maximum amount is limited to $100,000 annually, per spouse.

IRA withdrawals are reported on IRS form 1099-R, which is used to report distributions from retirement accounts. Typically, amounts reported on 1099-R are treated as ordinary income; however, a QCD is not. The amount contributed to a QCD must be entered correctly on your tax return to ensure it is not taxed.

This next part is crucial. The distribution must go directly to a 501(c)(3) organization as they are eligible to receive tax-deductible IRA contributions. The distribution should be paid directly by the trustee of your IRA, the IRA custodian, to the charity.

Two other important things to note:

You do not need to take RMDs from Roth IRAs, as the distributions are already tax-free.
You cannot make a QCD to a donor-advised fund.

How Do You Calculate Required Minimum Distributions?

Your required minimum distribution is based on your life expectancy and the balance of your retirement plans. The IRS has RMD tables that include a life expectancy factor for each year from age 70 to age 115.

Starting in 2022, the life expectancy tables will be updated to reflect the increase in life expectancy since the early 2000s. Ultimately, this means that smaller annual distributions will be required. This means IRA owners will pay less in tax and can allow their money to grow further over the long run.

How Much Does a Qualified Distribution Save in Taxes?

You do not directly save anything from a qualified charitable distribution, as you have donated money instead of paying taxes on the same amount. However, a QCD may keep you in a lower tax bracket.

Staying in a lower tax bracket may be necessary for certain senior benefits, such as Medicare and Social Security. A lower tax bracket also results in fewer taxes on your other income.

For example:

Susan’s 2021 RMD is $40,000. She earns $54,750 working throughout the year. With a taxable income of $40,500 after taking the standard tax deduction, she would be in ~12% in the federal bracket. However, Susan’s RMD would increase her taxable income and would be subjected to the 22% tax bracket. If Susan completed a QCD for $40,000, her RMD becomes $0 and her taxable income remains at $40,500, keeping her in the 12% tax bracket.

Conclusion

Our Bethesda, MD financial planning firm regularly helps clients determine whether a qualified charitable contribution made from their IRAs can help reduce their tax burden. Remember: For every dollar that you donate (up to $100,000/year) to a qualified charity, you reduce your required minimum distribution by a dollar. You also reduce your taxable income for the year, which may keep you in a lower tax bracket.

Working with a fee-only, fiduciary financial planning firm can help identify whether this strategy is right for you.

Discuss your situation with a fee-only financial advisor.

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